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An average return isn’t a today return

QUESTION: You’ve said that a person could earn six percent on savings. When will you journalists and financial advisers start telling the truth — that a more reasonable earnings rate would be two percent, especially after inflation? One must only look at the average interest rate over the last 15 years and the Dow Jones Industrial Average (14,000 in 2000 and now 15,500). If I had been able to earn six percent on my savings over the last 15 years, I would have doubled my money. In reality, that has not happened. —C. R., by email from Dallas, TX

ANSWER: This coin has two sides. During the 1980s and '90s, financial advisers and financial journalists routinely cited long-term average returns — about 10 percent for stocks, five percent for bonds in nominal terms — while market returns were inspiring manic behavior and expectations that stocks commonly doubled in a few years.

Today, we have the other side of the coin, financial advisers and financial journalists continue to cite long-term averages, often shaded lower to reflect current beliefs about lower returns in the future, while most people are concluding that investment returns don’t really exist.

Time will tell, but my bet is that a bull market will start about the same time that most people would rather drink cyanide than own shares of stock. Meanwhile, the best thing an objective observer can do is remind people that averages prevail over long periods of time.

Q: I have some concerns with my investment adviser. He uses Schwab to hold the investments. My IRA is small potatoes but it is what we have. We started Jan. 1, 2015, with $180,000 and after two mandatory distributions it is now $157,000.

I pay a 1.5 percent annual fee by quarter to my adviser. My employer had me take about a 4 percent distribution in 2015 because I would turn 70 ½. This January, I took another 4 percent distribution.

My adviser has me in 25 funds, rated three to five stars. But only six of the 25 have made money. I know the market is down. Last year, he told me we would get better in 2016. How can he keep up with 25 funds? I thought the most I would have is six to eight funds. I would need to earn nearly six percent just to break even with fees and distributions.

I feel that I am quickly draining my meager IRA funds. We have pensions and Social Security and are living comfortably. The IRA is to fund our travel and other special projects. What do you suggest? —F.T., by email from Austin, TX

A: That 1.5 percent fee is entirely too high. And 25 funds is silly; it’s an extravagant display of excess. You can get very good diversification with four to 10 funds. Many advisers key the number of asset classes they invest in to the size of the account.

When you have $5 million, you can have fun with obscure asset classes. Even if you lose money, the obscurity makes good party conversation, e.g. “Last year was good except I got whacked in Russia.” But with $180,000 you keep it simple and invest in a small number of asset classes.

My basic Couch Potato Portfolio, for instance, has two asset classes. It has the U.S. Total Stock Market and U.S. Inflation Protected Treasury Bonds. You can also substitute the U.S. Total Bond Market for the inflation-protected securities. Both can be purchased as mutual funds or as exchange traded funds.

At Schwab, for instance, you can build that portfolio with shares of SCHB, the U.S. Broad Market ETF and SCHP, the U.S. TIPS ETF. The average annual expense ratio for this portfolio would be 0.05 percent.

Another alternative is to invest in a mutual fund that invests in different asset classes for you. Either way, you can have total expenses from about 0.5 percent down to less than 0.05 percent.

Your adviser hasn’t adapted to the new low-returns reality. When the total cost of your investment management exceeds the total interest and dividend income from the portfolio, your adviser has the mine and you have the shaft. The adviser has the income, you have the risk. You just can’t allow that.

The simple alternative is to quit the adviser and put your money in low-cost index funds. I’ve cited Vanguard Balanced Index fund for decades. But you can also create the same fund by using Schwab exchange traded funds. They are sold without commissions and their annual cost is a bit lower than the comparable Vanguard fund.

You can terminate your adviser relationship at will, no questions asked. A visit to your Schwab office will start the ball rolling.

Scott Burns is a syndicated columnist and a principal of the investment firm AssetBuilder Inc. Email questions to scott@scottburns.com.